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March 03, 2009

Steps toward an energy solution 5

Step 5 - Adopt A New Kind Of Money Based On Energy

In one sense this step (actually to be done in parallel with other steps) is the easiest. Yet in another sense it will be the hardest. It will be a lot like the adoption of the metric system. The system itself is clean, efficient, easy to work with numerically, and about as rational as a measurement system can be, yet the American people just could not grasp it!

Fiat money has to go. The banking system as we've come to understand it has to go. Money should be worth some real quantity that is directly associated with the production of real wealth. And it cannot be created magically by something like fractional reserve banking (loaning someone else's money out to create new circulation while pretending to still have that person's money still on deposit). Nor can there be speculative markets where values magically appreciate just because time passes and demand seems to grow. It is all of this nonsense that has brought us to our knees in the current financial meltdown. Everyone was speculating on everyone else's desire to bid up prices of so-called assets, houses, stocks, you name it. A lot of ephemeral money was magically created to give the illusion of wealth — at least for those who truly believed in the magic. But in reality, which has now raised its ugly head, no real wealth was being created, only empty bubbles that easily popped.

We shouldn't try to base money on any specific commodity either. Gold has been used as a currency basis and that didn't work too well. Gold has no intrinsic value, nor does platinum or silver, or any other hard commodity. Food stuffs, like grains, have intrinsic value but fail the storehouse test. What is needed is a certificate (paper money) that represents something that has intrinsic value, specifically value representing real work that is to be accomplished or has been accomplished in the past. By real work, of course, I mean REAL work — in the physical sense. In physics there are several different forms of work, e.g. mechanical, electrical, and chemical. All of these involve the transformation of energy as it flows through the work process. Each transformation involves an irretrievable loss of some of the original energy so energy gets used up in doing work. It has to be resupplied anew in order to continue performing work.

The potential to do work in the future is measured by how much energy is available that can be directly coupled to the work process. This is generally a fraction of some raw energy form like sunlight. We can measure the fraction of sunlight that is able to drive, say, photosynthesis. The technical term for this energy fraction is 'exergy'. In the end, what counts as usable energy is that which drives our prime movers and heaters (including our own bodies). So, for example, only the amount of electricity delivered to the outlet in your home would count as exergy. All of the raw energy in, say, the coal burned to make steam, which drives the turbine generator, which pushes electric current hundreds of miles through copper wires to get to your home, is not available in the form of power coming out of your outlet. Nevertheless, by knowing how much coal was burned (by weight and energy content per unit of weight) we can compute a pretty good estimate of how much exergy, on average, we are producing.

All work of all kinds, even frivolous things like getting the family to the NASCAR race, consumes energy and it will be lost forever (Second Law of Thermodynamics). And everything we do involves work of some kind. Even thinking is electrochemical work. Of all the possible physical quantities that we could reasonably consider as the basis for a rational monetary system, it would be exergy. We can't do more work, or create more wealth doing the work, then there is exergy to back it up.

Once we have created, say, a product or performed a service, we have the results which should persist for some time into the future. Those products, and the effects of those services, should actually allow us to do more work in the future. For example, using some of our labor to craft plows allows us to plant and harvest more food per increment of time. Or, we could save time by producing the same amount of food as before, but in a shorter time period thanks to the efficiency of the plow. Either way we are wealthier and better off by judiciously using our exergy.

To create a monetary system, for the purposes of facilitating trading, all that is needed is to assign a standard energy measure, such as joules (or BTUs or calories) to a certificate (with multiple denominations such as we have now). For example, one dollar could be worth x joules, where x is determined initially to account for the amount of energy a typical household uses (in joules) and to provide a reasonable number of certificates per household.

Accounting systems would have to switch to counting and apportioning these certificates, but their methods would not be altered substantially. Products and services could be costed in terms of the amount of energy each unit required to complete it (labor, machine, and overhead). This latter measure of energy is called 'emergy' or embodied energy. It isn't actually energy per se, it isn't some kind of potential energy as you would have in a battery, it is just a measure of exergy expended in producing the product (or service). Cost accounting would barely have to change its processes to use this new currency. And the cost basis of a good or service would completely capture the resources it required to produce. This is because every value-added step in the supply chain would be using the same exergy used basis for costing, so this real cost would be reflected in the price they charge to their customers. It applies even to costing externalities such as pollution mitigation where it takes extra energy to process wastes. It works on the finite (or slow regenerating) resource depletion side as well. As ores become less concentrated it takes more energy to extract and refine the metals sought.

As for prices the big issue comes down to what do we mean by profit. How much above cost should a producer be allowed to charge for a good or service? In our current economic model, in a semi- laissez-faire system, we allow sellers to charge whatever the buyers are willing to pay. In part this is seen as part of a natural feedback mechanism that matches buyer utility with product or service value. If demand is high the seller should be able to charge any price above real costs and make a handsome profit. But there is a serious flaw in this logic. It depends upon some notion of rational utility maximizers and the equilibrium point in supply and demand. Now we know that buyers, who haven't got a clue as to how much actual value went into the complex electronic gizmos and feature loaded SUVs and have even less conscious understanding of what pleasure they will get out of those things will be, are anything but rational. Nor are they utility maximizers. They will pay a price based on the fact that that is what everyone else has paid so it must be worth it!

The supply-demand equilibrium is similarly flawed by the fact that growth (either in demand or supply) is not an infinite proposition. It has always seemed that way because of one simple fact of our modern world: Energy supply — specifically exergy — has always been increasing in the past. As long as in each increment of time there was a gain in energy available then some versions of growth were feasible. More energy made it possible to build more units of something, seeming to drive the prices down (economies of scale). But now we have entered a completely new regime in which exergy supplies are contracting even while we are working to expand our raw energy supplies. That means less, not more, work can be done in the future. Less, not more, wealth will be produced. And since the entropy version of the Second Law of Thermodynamics tells us that things wear out, they don't spontaneously get better, we will be poorer in the future, not wealthier. Unless, of course, we find some fantastic way to increase our supply of exergy!

Prices should reflect true energy costs including the costs in labor applied. Much thought needs to be given to the nature of profit and how much above energy costs profits should be allowed. One way to approach this would be to value work for its potential contribution to future exergy supplies. In other words, if a product (or service) will enhance the availability of exergy in the near future then some fraction of that increase should be available to the producers. This would apply to human labor as well. One's take home pay would reflect not only one's energy expenditure doing the job, but also include the value to one's contribution to expanding exergy for the future.

So trade valuation can be established based on some real physical facts rather than whims and fancies. No amount of advertising will up the price of an item that has a cost fixed by energy consumed, or worse, energy that will be consumed in the future with no contribution to expanding exergy!

Finally, there is the question of monetary policy regarding how much money should be in circulation at any given time. Currently this is controlled (or so the Fed claims) by the interest rate charged to banks. Banks with lower reserve requirements and favorable interest rates tend to loan out more money thus creating the illusion that the economy is growing. If the Fed screws up and puts interest rates too low, then it has the effect of heating up the economy and possibly leads to inflationary pressures — too much apparent money for the goods and services produced. If they set interest rates too high it can have a stultifying effect on economic growth leading to unemployment and other perceived negative results that embarrass the politicians.

But if money is tied to a physical quantity of exergy, as suggested here, then the total volume of money is determined by the total amount of exergy in production. This can be fairly easily estimated and tracked over time. If the exergy supply is contracting then the money supply should contract accordingly. Vice versa; if the exergy supply is expanding then the money supply should expand as well. Some major benefits derive from having a money supply tied so directly to the ability to do work. For one thing the amount of money will always match the production of goods and services so that there can not be inflation or deflation (there may need to be additional regulation forbidding the attempt to artificially inflate prices of commodities in re-sale markets, but the rule about reasonable profit determination might suffice).

This proposal will never fly in today's environment. As the politicians and economists struggle mightily to make our borrow-and-spend consumer-based economy work again they will double down on classical economic theories and beat their heads against the wall trying to make it go back to 'normal'. The only problem is that they are beating our heads as well as their own. And there is no sign that they will stop and think or ask the question: If things aren't working according to the plan based on the old theory, could we possibly need a new theory? Such is faith-based economics.

Hi, so I'm just starting to learn about economics. I'm pretty skeptical of many of the mainstream ideas, and very sympathetic to your goals, but there's something about your plan that doesn't quite make sense to me. The problem I see is that the system you describe doesn't seem to have any way of accounting for people's preferences which, as I understand it is a major role of our current money system. How would one person buy something from another person when the price of that object is fixed? What if the seller is unwilling to sell at that price, but the buyer is willing to spend a higher price that both agree to? Traditionally this trade would be seen as creating a more satisfying situation for both people (a Pareto improvement). Another problem is allocating very scarce or positional goods - how much is waterfront property worth? It doesn't necessarily take any more energy to produce or maintain than an inland parcel of land of the same size, but there is not enough waterfront property for everyone to have an ocean view. If we cannot price these things according to how much people value them, how do we decide who gets them? And assuming the world is best off when the people who want something the most are the ones who get it, how can an efficient allocation be achieved?

I hope this comes across as helpful rather than critical. If I felt qualified I'd try to suggest some solutions.

Hm. The plow example suddenly made me doubt...: So, we got that shiny new plow. The energy invested gets well returned by higher productivity for some time - until suddenly the field's humus/carbon is exhausted because the deep plowing oxydized it away. And the comes the dust bowl...
(A similar classic is applying too much lime - a saying here in Germany goes like: Lime makes rich fathers and poor sons.)

These are good points. But they all are predicated on the BAU notion in economics that starts with freedom of choice. If there really were complete freedom of choice in nature and the economy, then the classical economic notion of utility and market prices being established by desires is clearly OK.

But my point is there really isn't the kind of freedom of choice that most economists subscribe to. It starts with the laws of physics (specifically the laws of thermodynamics). We like the illusion that we have choices and that if we feel a value for anything that is for sale, we should be able to pay whatever we can afford to get it.

Unfortunately this simply isn't the case in physical reality. And my starting premise is that we are subject to physical reality just as much as the rest of nature. We must attend to constraints on trades and those start with energetics.

One resolution to the waterfront property, for example, is to not allow anyone to own such property unless their use of it advances the production or saving of exergy. This is clearly a restriction on our so-called freedoms. But it also recognizes that people occupying waterfront just because they can (apparently) afford it turns out not to be a good idea. Think of what happened to the wetlands around New Orleans due to occupancy - and how things turned out with Katrina!

The best current example of why we should forgo our beliefs in complete freedom of choice and unfettered markets is what is happening now in so many of the financial and real estate markets. When people feel free to pay whatever they want (and sellers to charge whatever the traffic will bear) we stand the risk of bubbles - inflation of prices for no other reason than people feel they are in competition to 'own' some perceived asset.

The plow example was meant simply to point out the nature of increasing exergy by increasing efficiency. You are right, of course, that there are always second-order effects and unintended consequences from any new invention. My proposals to incorporate hierarchical control systems thinking in governance is, in part, to provide mechanisms to regulate such unanticipated results.

On the other hand, if we were wise about what to do once an invention increases our potential exergy, we would turn it into conservation (keep it potential for a longer time) and not turn our savings into new growth. In the case of the plow, it would have allowed us to turn fewer acres of land into farm rather than choose to farm more land, presumably to create greater riches (and produce more children).

It is our choices of what to do with increased exergy that are problematic, not the principle in and of itself. Lacking inherent wisdom about the nature of systems, balance, etc. we have invariably chosen the growth option which leads to scaling issues for any industry we undertake.

Imagine what life would have been like for a species that naturally grasped the notion of savings for the future and did not elect to spread and conquer nature.

Hope this explains it better. I'm with you though. Given the kinds of foolish choices our species makes in practice it would seem not such a good idea to create more exergy! My argument is that if we see our past mistakes for what they were, we should learn and change our ways. On that score I am not terribly hopeful, however.

I have never heard of the "Mathematically Perfect Economy" theory so I am not qualified to comment on it. As far as interest on money I certainly agree that the whole concept of interest as profit is problematic and probably the reason the early Christians (among others) forbade usury.